Three pitfalls of early-stage marketplaces

This is a guest post by Juho Makkonen, CEO and co-founder at Sharetribe. Sharetribe builds software tools to help entrepreneurs create their own sharing economy platforms quickly and with a low budget.

Online marketplaces are a megatrend with no end in sight, but building a successful platform business is challenging. Many of the most common pitfalls for early-stage marketplace entrepreneurs can be avoided when you approach your marketplace as a process, not a project.

There are many reasons why a marketplace can be a really great business.

For one, marketplaces usually don’t need initial inventory. Unlike a brick and mortar store or a traditional e-commerce site, a marketplace business can launch without first investing in storefronts, product stock, storage spaces, or even a dedicated office.

Secondly, a marketplace platform can be built very efficiently. Only a few years ago, setting up a platform with all the necessary features meant building it from scratch, which takes a lot of time, money, and technological know-how. Today, a number of SaaS companies offer platform technology at a fraction of the cost. This makes starting a marketplace business possible for everyone—including people without a big budget or extensive technological expertise.

Furthermore, successful marketplace unicorns like Etsy, Airbnb, and Uber have laid the groundwork and introduced large audiences to the way marketplaces work. They have managed to convince consumers to change their behavior and do something they’re used to doing—like booking a hotel or getting a cab—differently. Today, if you say you’re building “an Airbnb for saunas” or “an Uber for personal trainers”, most people will instantly understand what you’re about. When a new platform with an appealing value proposition emerges, potential users need much less persuading to trust the platform and give it a try.

With such significant advantages, it’s no surprise that a wave of new marketplaces for a variety of markets and industries has emerged. And this is only the beginning! According to marketplace investor Josh Breinlinger, there seems to be “no end in sight for marketplace opportunities”—yours could very well be the next marketplace success story!

This is not to say that marketplaces can’t fail. In fact, working with marketplace entrepreneurs on a daily basis, we have noticed some pitfalls that lurk particularly in the early stages of a founder’s path. Many start their marketplace without properly validating their idea and end up solving a problem that isn’t there. Another common mistake is for entrepreneurs to not understand the concept of liquidity and its importance to marketplaces, and then making matters worse by working with too broad a focus.

We’ll untangle these three pitfalls so you can get going with your marketplace business without making the same mistakes.

Your problem isn’t there

If you have a great marketplace idea, you might be tempted to launch it as quickly as possible. Intuitively, this makes a lot of sense. Once your platform is live, you’ll get to interact with your users, receive feedback, and see how you can develop your marketplace further. Besides, with the boom of marketplace businesses going strong, who knows if a competitor is building a similar platform as we speak and is close to beating you at the race to market?

However, before you write the first line of code—or even before you subscribe to a platform tool like Sharetribe—there are steps you can and should take to make sure your marketplace is solving a real problem.

Every business begins with a set of assumptions or hypotheses. Your very first goal before starting your business is to understand what your assumptions are, and how you can validate them.

This can be more difficult than it sounds—when you are sure you have a great business idea, it’s easy to get carried away by it and wind up ten assumptions deep. That is why we suggest using tools like the Business Model Canvas recommended by Steve Blank or Simone Cicero’s platform design toolkit and the Platform Design Canvas featured there.

These tools can help you map out different aspects of your business idea and get to the bottom of the assumptions behind them. You will likely have many different types of hypotheses: some regarding your value proposition, some about your customer segments, your distributions channels, your revenue streams, and so on. Furthermore, marketplaces typically have two completely different types of users—customers and providers—meaning a different set of assumptions for both sides.

After you have mapped out your assumptions, it’s time to get out of the building and talk to potential providers and customers. This is a crucial step—one you should not neglect or outsource. Ideally, you’ll find at least ten people to interview on each side. Ask open-ended, not-too-specific questions and check which assumptions hold true and which ones you should reject. You can also study online search data to find out if people in your city are searching for keywords that are relevant to your marketplace.

After going through this process, you should have a good idea of what types of problems your potential users really have, and how you could go about solving them. When it’s time to start building the first iteration of your platform—your Minimum Lovable Platform—you’ll know what the absolute essential functionalities are, and what are technical details you can focus on later.

You haven’t achieved liquidity

If there was a competition about the quote we repeat the most often, a strong candidate would be one by Simon Rothman:

“Liquidity isn’t the most important thing. It’s the only thing.”

In a marketplace context, liquidity means that your providers can reasonably expect to sell something they list, and your customers can reasonably expect to find what they are looking for. Marketplaces should keep track of both provider liquidity and customer liquidity.

Your first job as a fresh marketplace entrepreneur is to achieve liquidity.

Liquidity is measured as a percentage. To find out your provider liquidity, look at the percentage of listings that lead to transactions within a given time period. The time period you should focus on will depend on your marketplace type. For product marketplaces such as Etsy, looking at the percentage of stock being sold per month is likely a good tactic. For marketplaces like Airbnb or Uber, finding out the occupancy rate on a daily or even hourly basis is more relevant: how big a percentage of bookings are made for each night, or how many of the listed cars are in use each hour.

Measuring customer liquidity is a bit more straightforward. The simplest way is to calculate how many visits you get on a given month (not including bounced visitors), and how many of those visits lead to a transaction.

As an early-stage marketplace entrepreneur, assessing your provider and customer liquidity will likely leave you facing the infamous chicken and egg problem. You need more quality providers to get your customer liquidity up, but providers will only join your platform if it looks like there are enough customers for them.

You’re building something for everyone

One of the most common reasons why marketplaces fail is that their focus is too broad.

Startup owners are frequently taught that their single goal should be to grow as fast as possible. What would be a better way to do it than to go for the biggest audience possible—to start off with a huge geographic market, or build a horizontal marketplace where everyone can sell or rent anything?

We recommend doing the exact opposite. Focus tightly on one, restricted location and one vertical, particularly if your providers and customers need to meet face to face. Why?

Because the bigger you are, the harder it will be to achieve liquidity.

A marketplace can only scale sustainably if providers are likely to sell what they are listing and customers can find what they are looking for. When your focus is narrow, reaching this goal will be much easier.

There is a reason why many of James Currier’s 19 tactics for solving the chicken or egg problem are about focusing on a niche or otherwise constricting your marketplace. With a narrow focus, you reach your critical user mass and liquidity faster. You can target your marketing extremely efficiently, you will know how to talk about your platform in a language your users relate to, and you will be able to create content that is valuable for them. All this will help you build a community of engaged users around your product.

If you target a huge audience from the start, building a sufficient amount of supply and demand will take a great deal time and money—resources an entrepreneur with a narrower focus can use to improve the platform further. Which brings us to our second point, namely: you shouldn’t optimize for fast growth, but fast learning.

Building a marketplace is a process, not a project. Validating your idea and building version 1.0 of your platform is only the beginning. The best marketplace businesses are the result of constant iteration and improvement, and the foundation is the insight you get from your early users.

With a small but strong community around your platform, you will be in a strong position to validate your marketplace idea and unearth the biggest flaws and development needs.

As the startup guru Paul Graham once advised Airbnb founder Brian Chesky: “It’s better to have 100 people love you than one million people that sort of like you.” When the time comes, a great product with a small group of committed users is a solid foundation for scaling sustainably.

Summary

There are many reasons why a marketplace can be a great business, but building a successful platform business is challenging. In particular, there are three major pitfalls where many budding marketplaces tremble and fall.

If a marketplace isn’t solving a real problem, it will not gain traction. As an entrepreneur excited about turning a great idea into reality, there is a danger of layering assumptions upon assumptions without truly knowing if the fundamental business idea is valid. At this stage, it is important to take a breather and use some tools and techniques outlined in this article to see which assumptions hold true.

The second problem is that many marketplace entrepreneurs do not understand what liquidity is, let alone having tactics to achieve it. Put simply, your providers need to have a high likelihood of selling what they list, and your customers need to be able to find what they’re looking for. Achieving liquidity is further complicated by the so-called chicken and egg problem: to build supply, you need attractive demand, but to bring in demand, you need interesting supply.

The chicken and egg problem of an early-stage marketplace is much easier to solve if your marketplace’s focus is narrow. Yet, the third problem we frequently see is that marketplaces launch targeting a massive audience, or try to build an all-encompassing “Uber for everything”. Focusing too broadly is often a failing strategy because you end up building a platform that many people sort of like when you should strive towards a solution some people absolutely love.

Remember that a marketplace is a process, not a project. You should take the time to build a small but strong community around your product. Once you have that, you have a solid foundation upon which you can start building your global marketplace success story.

About the author

Juho Makkonen has been building marketplace websites since 2008. He is a co-founder of Sharetribe and currently serves as the CEO of the company. He’s also a OuiShare connector in Helsinki and a longtime advocate of the sharing economy.